The Difference Between Expense and Liabilities
In business, two main terms often get confused: expenses and liabilities.
Expense is what a company spends to make money, while liabilities are what it owes to other people or organizations.
This article will discuss each term and outline the key differences between an expense and a liability.
What is an expense?
The definition of an expense is “a cost incurred in the course of doing business.” This can be anything from the cost of goods sold to employees’ salaries. Generally, expenses are recorded as deductions against revenue on a company’s income statement (profit and loss).
An expense is an outlay of cash or other resources that a business or individual makes to acquire or maintain something of value. Most expenses are classified as either fixed or variable, depending on how much they vary in relation to the amount of sales revenue generated.
Types of Expenses
There are three types of expenses: fixed, variable, and periodic.
Fixed expenses tend to not change and remain the same from month to month. This might include rent or equipment leases. Often, businesses will have fixed expenses to maintain continuity and predictability in their monthly budgets.
For a small business, having a fixed rent expense is crucial to maintaining cash flow, as it allows for budgeting and forecasting long-term.
Variable expenses change from month to month, typically depending on the level of sales or business activity. Common examples include employee commissions and utility costs.
A company’s accounting department must carefully track these expenses to ensure they are not incurred in excess and do not impact the business’s bottom line.
To manage variable expenses effectively, a business should establish a budget and track actual spending against that budget. This allows for timely corrective action if necessary.
Periodic expenses are those that happen occasionally and are usually planned in advance. They can include things like business holiday events or planned promotional outreach.
These expenses can be challenging to budget for because they don’t happen regularly. However, it’s important to factor them into your overall budget ahead of time so you can stay on track with your finances.
What is a liability?
A liability is a financial obligation or debt of a company on a future date. Liabilities are recorded on the balance sheet and can include accounts payable, wages payable, and taxes payable.
A company’s liabilities can also include long-term debt and notes payable. Generally, the higher a company’s liabilities, the greater the risk that the company will have of not meeting its financial obligations.
How Liabilities Work?
Generally, a liability consists of an obligation by both parties to be completed or paid. In accounting, it is often understood as being a liability for a company to carry on a business transaction. However, it is more defined by previous business transactions, events, sales, exchange of property or service, or something generating monetary benefits at a later date.
Current liabilities are generally considered short-term (expected to be paid off within at least 12 months). Non-current debt is long-lasting, also known as long term liabilities, scheduled to be paid beyond 12 months or more.
How do I know if something is a liability?
Usually, liability involves something due to another person. The situation may be genuine, such as bills that must be paid.
The difference between expenses and liabilities
An expense is something that is incurred in order to generate revenue. A liability, on the other hand, is a debt or obligation that a company has. The main difference between expenses and liabilities is that liability must be paid back, while expenses are one-time costs.
For example, rent would be an expense, while a loan from the bank would be a liability.
Expenses are typically short-term, while liabilities are long-term obligations. An expense is something that a company spends money on in the present, such as food or rent. A liability is something that a company owes in the future, such as a loan or a bond.
Expense refers to the costs incurred in the course of doing business, while liabilities are amounts that a company owes to others. Expenses are typically recorded in the period in which they are incurred, while liabilities may be incurred in one accounting period but not paid until a later period.
For example, a company might owe its supplier for goods it received in the current period but has not yet paid for. The supplier would be considered a liability to the company.
How to differentiate between Liabilities and Expenses
To differentiate between liability and expenses, it is important to understand the fundamental difference.
Liability is a fixed amount that must be paid either long term or short term, whereas expenses can be fixed, variable, or periodic expenses that will be paid at the time of occurrence.
Do remember, a liability is the potential legal obligation of an organization, such as a debt or a lease. Expenses are the costs incurred by an organization in the pursuit of its objectives.
Examples of expenses vs. liability
To elaborate on the differences between an expense and a liability, let’s get into the example accounts below.
Expenses can fall into different categories on the income statement. The most common is the cost of goods sold (COGS), operating expenses, and other expenses.
Costs of goods sold are the direct costs associated with making or acquiring the products or services that a company sells. Operating expenses or overhead expenses are the indirect costs of doing business, such as rent, utilities, and administrative salaries.
Other common expenses include marketing and advertising costs, taxes, and interest payments on loans.
Liabilities are also divided into different categories. The most common liabilities found on the balance sheet are current and short-term liabilities.
Common current liabilities include:
2) Notes payable
3) wages payable
4) Interest payable
5) Unearned revenue
Common Long Term Liability includes:
1) Notes payable
2) Bonds payable
These liabilities arise when a business has incurred an obligation to pay a creditor and has not done so yet. For example, a business might have to pay its suppliers for goods it has purchased on credit. Other liabilities might include long-term debt, taxes, and leases.
Expenses are outlined on the income statement, and liabilities are listed on the balance sheet.
Balance sheet vs. Income statement
The balance sheet is part of the financial statements. It shows a business’s assets, liabilities, and owners’ equity for a specified accounting period. As the name entails, the balance sheet must balance.
It represents the accounting equation:
Assets = Liabilities + Equity
The income statement is a financial statement that shows a business’s revenues and expenses over a specific period of time. These two financial statements are related because the income statement shows how the changes in assets and liabilities affect the business’s profits during an accounting period.
Are Expenses Liabilities?
Expenses are not liabilities. This is because expenses are incurred in the course of running a business, whereas liabilities are amounts that a business owes to others. For example, rent is an expense, while a loan from a bank is a liability.
For further explanation, an expense is an event that consumes economic resources but does not create a legal obligation. For example, when a company pays for office supplies, the payment is an expense, but the company is not obligated to pay the supplier any further money.
Tell me the difference between current liabilities and non-current liabilities?
A current liability is a debt that is due within one year, while a non-current liability is a debt that is due after one year. Non-current liabilities are also called long-term liabilities.
The most common type of current liability is Accounts Payable, which is money that a company owes to its suppliers for products or services that have been delivered. Other common types of current liabilities include short-term loans and notes payable. Non-current liabilities can consist of long-term loans, mortgages, and bonds.
To understand the differences between expense and liability, you must first learn the definition of the two. A liability is an obligation while an expense is incurred while doing business.
A liability account will be found on the balance sheet along with assets and equity, which represents the accounting equation. Expenses live on the income statement along with other accounts that deal with operations.
A good rule of thumb to remember is that liability is an obligation on a future date, whereas expenses are costs that generate revenue.
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